Chapter

Multinational Financial Management: An Overview

South-Western/Thomson Learning 2003

Goal of the MNC

The commonly accepted goal of an MNC is
to maximize shareholder wealth.

We will focus on MNCs that are based in

the United States and that wholly own their foreign subsidiaries.

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Conflicts Against the MNC Goal

For corporations with shareholders who
differ from their managers, a conflict of goals can exist - the agency problem.

Agency costs are normally larger for MNCs

than for purely domestic firms. The sheer size of the MNC. The scattering of distant subsidiaries. The culture of foreign managers. Subsidiary value versus overall MNC value.
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Impact of Management Control

The magnitude of agency costs can vary
with the management style of the MNC.

A centralized management style reduces

agency costs. However, a decentralized style gives more control to those managers who are closer to the subsidiarys operations and environment.

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Centralized Multinational Financial Management

for an MNC with two subsidiaries, A and B Cash Management at A Inventory and Accounts Receivable Management at A Financing at A Capital Expenditures at A Financial Managers of Parent Cash Management at B Inventory and Accounts Receivable Management at B Financing at B Capital Expenditures at B
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Decentralized Multinational Financial Management

for an MNC with two subsidiaries, A and B Cash Management at A Inventory and Accounts Receivable Management at A Financing at A Capital Expenditures at A Financial Managers of A Financial Managers of B Cash Management at B Inventory and Accounts Receivable Management at B Financing at B Capital Expenditures at B
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Impact of Management Control

Some MNCs attempt to strike a balance they allow subsidiary managers to make the key decisions for their respective operations, but the decisions are monitored by the parents management.

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Impact of Management Control

Electronic networks make it easier for the
parent to monitor the actions and performance of foreign subsidiaries.

For example, corporate intranet or internet

email facilitates communication. Financial reports and other documents can be sent electronically too.

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Impact of Corporate Control

Various forms of corporate control can
reduce agency costs. Stock compensation for board members and executives. The threat of a hostile takeover. Monitoring and intervention by large shareholders.

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Constraints Interfering with the MNCs Goal

As MNC managers attempt to maximize
their firms value, they may be confronted with various constraints. Environmental constraints. Regulatory constraints. Ethical constraints.

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Theories of International Business

Why are firms motivated to expand their business internationally? Theory of Comparative Advantage Specialization by countries can increase production efficiency. Imperfect Markets Theory The markets for the various resources used in production are imperfect.
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Theories of International Business

Why are firms motivated to expand their business internationally? Product Cycle Theory As a firm matures, it may recognize additional opportunities outside its home country.

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The International Product Life Cycle

Firm creates product to accommodate local demand. Firm exports product to accommodate foreign demand. Firm establishes foreign subsidiary to establish presence in foreign country and possibly to reduce costs.

a. Firm differentiates product from competitors and/or expands product line in foreign country.

or b. Firms foreign business declines as its competitive advantages are eliminated.

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International Business Methods

There are several methods by which firms can conduct international business.

International trade is a relatively

conservative approach involving exporting and/or importing. The internet facilitates international trade by enabling firms to advertise and manage orders through their websites.
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International Business Methods

Licensing allows a firm to provide its
technology in exchange for fees or some other benefits.

Franchising obligates a firm to provide a

specialized sales or service strategy, support assistance, and possibly an initial investment in the franchise in exchange for periodic fees.

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International Business Methods

Firms may also penetrate foreign markets
by engaging in a joint venture (joint ownership and operation) with firms that reside in those markets.

Acquisitions of existing operations in

foreign countries allow firms to quickly gain control over foreign operations as well as a share of the foreign market.

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International Business Methods

Firms can also penetrate foreign markets
by establishing new foreign subsidiaries.

In general, any method of conducting

business that requires a direct investment in foreign operations is referred to as a direct foreign investment (DFI).

The optimal international business

method may depend on the characteristics of the MNC.
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International Opportunities
Investment opportunities - The marginal
return on projects for an MNC is above that of a purely domestic firm because of the expanded opportunity set of possible projects from which to select.

Financing opportunities - An MNC is also

able to obtain capital funding at a lower cost due to its larger opportunity set of funding sources around the world.
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International Opportunities
Cost-benefit Evaluation for Purely Domestic Firms versus MNCs
Investment Opportunities Purely Domestic Firm

Marginal Return on Projects Marginal Cost of Capital

MNC MNC Purely Domestic Firm

Financing Opportunities

Appropriate Size for Purely Domestic Firm

Appropriate Size for MNC

Asset Level of Firm

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Exposure to International Risk

International business usually increases an MNCs exposure to: exchange rate movements Exchange rate fluctuations affect cash flows and foreign demand. foreign economies Economic conditions affect demand. political risk Political actions affect cash flows.
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Overview of an MNCs Cash Flows

Profile A: MNCs focused on International Trade
Payments for products

U.S. Customers U.S. Businesses Foreign Importers Foreign Exporters

U.S.based MNC

Payments for supplies Payments for exports Payments for imports

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Overview of an MNCs Cash Flows

Profile B: MNCs focused on International Trade and International Arrangements
Payments for products Payments for supplies

U.S. Customers U.S. Businesses Foreign Importers Foreign Exporters Foreign Firms
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U.S.based MNC

Payments for exports Payments for imports Fees for services Costs of services

Overview of an MNCs Cash Flows

Profile C: MNCs focused on International Trade, International Arrangements, and Direct Foreign Investment
Payments for products Payments for supplies

U.S. Customers U.S. Businesses Foreign Importers Foreign Exporters Foreign Firms Foreign Subsidiaries
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U.S.based MNC

Payments for exports Payments for imports Fees for services Costs of services Funds remitted Funds invested

Managing for Value

Like domestic projects, foreign projects
involve an investment decision and a financing decision.

When managers make multinational

finance decisions that maximize the overall present value of future cash flows, they maximize the firms value, and hence shareholder wealth.

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Valuation Model for an MNC

Domestic Model
V l =
t =1

CF
1  k
$, t t

E (CF$,t ) = expected cash flows to be received at the end of period t n = the number of periods into the future in which cash flows are received k = the required rate of return by investors
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Valuation Model for an MNC

Valuing International Cash Flows
ER CF E  j , t v E  j , t !1 j = t 1  k t =1

V l

E (CFj,t ) = expected cash flows denominated in currency j to be received by the U.S. parent at the end of period t E (ERj,t ) = expected exchange rate at which currency j can be converted to dollars at the end of period t k = the weighted average cost of capital of the U.S. parent company
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Valuation Model for an MNC

An MNCs financial decisions include how
much business to conduct in each country and how much financing to obtain in each currency.

Its financial decisions determine its

exposure to the international environment.

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Valuation Model for an MNC

Impact of New International Opportunities on an MNCs Value
Exposure to Foreign Economies
m n j 1

Exchange Rate Risk

? CF E ER A E
j, t j, t

alue =
t =1

k
t

Political Risk
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